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FX Technical Outlook: Yen and Dollar Weakness Set to Continue

Last week, we recognized that the US dollar was overstretched and anticipated some consolidation/correction. Yet
the pace and magnitude of the move was surprising, especially in light
of the series of disappointing developments in Europe, which include the
initial failure to resolve Greece's funding problems and the EU's next
7-year budget. Nor was the economic data inspiring, as the main report
of the week, the Nov flash PMI reading, suggests the euro area economy
continues to contract here in Q4.

In contrast, the US reported stronger than expect existing home sales
and housing starts, as the painfully slow recovery in the housing market
continues. Weekly initial jobless claims slipped back as the impact of
the east coast storm fades. The newly introduced Markit PMI reading
was above consensus forecasts. The University of Michigan's final
consumer confidence measure for November was a bit softer than the
preliminary report, but still is at 4 1/2 year highs.

Admittedly, the key issue in the US is not how the economy is performing now, but the looming fiscal cliff. The
noises and signals emerging from Washington seemed to be a source of
some confidence that the worst of it will be averted, though we continue
to suspect that brinkmanship tactics will make for only a last minute
deal (if not a slightly later one) Yet the optimism was frequently
cited for the S&P gains last week.

Recall that the S&P 500 rallied about 16.5% from early June through mid-September. We turned cautious here(Sept
22), anticipating a decline to at least 1400. The S&P overshot
this, but staged a reversal on Nov 16 and saw impressive follow through
last week. In fact, the S&P's 4.1% advance last week, was the best
since June and all the main industry groups, save utilities,
participated.

With the pre-weekend advance, the S&P 500 has retraced 50% of its
two month slide. The next retracement level is near 1424 and the
month's high comes in near 1434. These are the main two technical
barriers ahead of a return to the year's high near 1475. We note that
the 5-day moving average of the S&P 500 is poised to cross above the
20-day average early next week. In addition, what could be a head and
shoulders bottom projects toward 1435. The correlations between the
foreign currencies and the S&P 500 has declined over the past few
months, but has begun to increase again recently.

Some observers emphasized that even though the European finance
ministers initially failed to reach an agreement on Greek funding, a
resolution remains imminent and that this lifted the euro. Since the
market did not punish the euro on disappointment, we suspect it is not
really rewarding the euro because of a soon-to-be-announced agreement. Moreover,
baring a dramatic reduction in Greece's debt, which given the ownership
structure, will require at some point at least partial forgiveness by
officials, the Greek situation will have to be revisited.

We do not see the price action in the foreign exchange market as being
fundamentally driven, though post hoc narratives can always be written.
Instead, we suggest that the dramatic sell-off in the yen, spurred by
anticipation that the next Japanese government will take aggressive
measures that will debase the currency. The yen's move forced cross
rate adjustments and this took on a life of its own.

Many short-term market participants had been leaning in the wrong
direction. The market had been technically poised to set the dollar
back, as we suggested last week the dollar bulls had over-reached, as
speculators in the futures market (a proxy, we think, for trend
followers and momentum traders) were adding on to short foreign currency
positions or cutting longs.

If this is correct, the performance of the yen may hold the key to the
general dollar performance in the days ahead. As we note below, we see
no technical sign that the yen has bottomed and this implies additional
near-term dollar weakness is likely. Good selling of the yen, against
the dollar and crosses, is still seen on the modest upticks. The weak
yen theme may also renew interest in using the yen as a funding
currency, ironically shortly after some observers sounded the death knell of the carry trade.

Euro: After spending most of the month below the technically
important $1.28 area, the euro jumped back above last week. A rounded
bottom has been carved out and the $1.2840 area should now offer
support. On the upside, the next test of the bulls' resolve will be in
the $1.3000-30 area. The potential downtrend drawn off the mid-Sept and
mid-Oct highs comes in near $1.31 by the end of the month. Technical
indicators, like RSI and MACDs, are constructive and the 5-day moving
average crossed above the 20-day average at the end of last week,
suggesting short-term models and momentum traders are getting positive
signals. Constructive technical outlook.

Yen: Japan's macro-economic conditions, like the contracting
economy, large, even if not heavy, debt burden, and deteriorating
external accounts, offer textbook fundamental reasons not to like the
yen. However, it took the threat of significant currency debasement by
the man expected to become the next prime minister to spur the yen's
slide. The adjustment does not appear over, even if the recent pace, a
3.6% slide since November 13 is not sustained. Dollar support is seen
near JPY81.60-80. On the upside, there has been reports of good demand
for JPY83 and JPY84 strikes. This year's high, thus far, was set in
March near JPY84.18. Last year's high was recorded in April near
JPY85.50. Demand for euros against the yen may have helped begun the
euro rally. The euro is poised to move toward the JPY111 area. Negative technical outlook for the yen.

Sterling: While it has lagged behind the euro, sterling has also
gained against the greenback. However, unlike the euro, sterling
closed only once below the 200-day moving average, where the euro spent
most of the month below it. Sterling's 5-day moving average has not
crossed above the 20-day average, it likely will in the week ahead.
Momentum and MACD indicators are constructive. The next technical
hurdle is seen near $1.6050 and when it is overcome, it could spur
another cent or so advance. Initial support is seen near $1.5960 and
then $1.5920. Constructive technical outlook for sterling.

Swiss franc: Dragged higher by the euro, the franc is poised to
appreciate further against the dollar in the period ahead. The dollar
has carved out a round top, confirmed by the push through CHF0.9400.
It is testing the CHF0.9280 area now on its way to CHF0.9200. However,
significant support for the dollar is not seen until closer to
CHF0.9200. The dollar's 5-day moving average crossed below the 20-day
on Thursday last week, a day before the euro's averages crossed.
Technical indicators suggest plenty of scope for additional near-term
dollar losses. Constructive technical outlook for the franc.

Canadian dollar: The Canadian dollar was the second worst
performer against the dollar over the past week, next to the yen. It
gained almost 1% against the greenback, but it is poised to extend those
gains next week. Trend line support drawn off the Sept 14 low
(~CAD0.9635) and the Oct 18 low (~CAD0.9765) comes in just above
CAD0.9900 at the start of the new week. A band of support extends to
CAD0.9875. There is potential toward CAD0.9800. Note, however, that
typically when the US dollar is offered, the Canadian dollar lags on the
crosses (except against the yen). Corrective bounces in the US dollar
may be capped by resistance in front of CAD1.0000. Constructive technical outlook for the Canadian dollar, but may continue to lag behind the European currencies.

Australian dollar: With news that the Chinese economy showing
signs of bottoming and many investors looking past the likely early
December RBA rat cut, that the Australian dollar advance is not
surprising. What is surprising is that it was among the weaker
performers. Technical tools are neutral to positive. The next are of
resistance is seen in the $1.0480-$1.0500 band. However, the critical
cap is not seen until closer to $1.0600-$1.0625, the highs from August
and September. Support is seen near $1.0380-$1.0400. Constructive technical outlook for the Australian dollar, but look for it to continue to lag.

Mexican peso: The dollar's recovery against the peso since
early October is over, with a convincing violation of the uptrend line.
New offers are likely to help cap dollar bounces in MXN13.05-08 area.
On the downside the immediate target is MXN12.90 and then
MXN12.77-MXN12.80. Long peso, short yen positions posses both carry
and momentum features. Constructive technical outlook for the peso and an attractive yield pick-up.MarctoMarket